New Era of Tax Planning

July 5, 2011 11:41 AM

by Tom O'Diam

New transfer tax law offers opportunity for family farms.

We all share a common goal of reducing the amount of taxes we pay. Unfortunately, few people take full advantage of the chance to minimize tax liability through careful planning. January 2011 ushered in a new era of federal transfer tax opportunities that never existed before—and they may not exist for long.

A transfer tax applies when you transfer assets to someone without receiving equal value in return. The estate tax on transfers at death is the most well known, but two other types of transfer tax play an equally important role in planning: the gift tax applies to lifetime transfers, and the generation-skipping transfer (GST) tax comes into play for lifetime or after-death transfers to someone who is two or more generations younger. When and how you transfer assets also determines future capital gains tax treatment.

Old versus new. During the past decade, transfer tax rules changed almost every year, which made planning difficult. Amounts excluded from the estate and GST tax steadily rose from $1 million in 2001 to $3.5 million in 2009. In 2010, estate and GST taxes disappeared. Gift tax exclusions remained at $1 million throughout that period. The tax rates declined from 55% to 45%. In 2011, the tax laws were supposed to revert to a $1 million exclusion and 55% tax rate.

Congress made a surprising move in late December 2010 that greatly improved transfer tax planning.

Instead of falling back to the old rules with lower exclusions and higher rates, we now have new rules with even higher exclusions and lower rates.

All three federal transfer taxes are now the same. A person can transfer up to $5 million during life or after death without any federal transfer tax. That means married couples can pass along $10 million, tax-free. The new exclusion amounts adjust with inflation. The tax rate on anything above the exclusion is 35%.

There are many other tax planning tools to further reduce or eliminate transfer taxes for amounts above the available exclusions. Special-use valuation rules and conservation easements allow you to reduce the taxable value of farm property. The type of business entity in which you hold your farming operation or land may also reduce the taxable value, while protecting the assets and facilitating easier transfer of the farm.

We also still have unlimited marital and charitable deductions. This means that transfers between
spouses or to qualified charities do not incur any transfer tax. Under the prior law, complex tax formulas were necessary to make sure both spouses maxed their exclusions. Under the new law, if the first spouse to die does not use all of his or her available exclusion, the surviving spouse can use it later without complicated planning. This new portability of unused exclusions may not be the best solution for some, though, as it may limit other planning goals.

Farmer benefits. A simple example illustrates the financial benefits of the new tax law. Assume that Frank and Fanny Farmer built a successful farming operation, which, with other assets, puts their net worth at $10 million. If the tax law had changed back to a $1 million exclusion and 55% tax rate, the Internal Revenue Service would receive $4.4 million in federal estate tax on the Farmers’ deaths before the farm could pass to their children. Their tax bill could even climb to $4.95 million if they did not both use their exclusions wisely. Under the new law, their estate tax bill is zero!

With a little extra planning, Frank and Fanny could use their GST exclusions to transfer their entire estate to their children, grandchildren and future generations for decades to come with no more transfer taxes. Even the future appreciation on those assets would escape later transfer taxes. Essentially, they could shelter the family farm from future transfer taxes. At the same time, their plan could protect their entire estate from creditors, divorces and other devastating events that could wreak havoc on their family farm.

Don’t skip the planning stage. Just because the new transfer tax rules ease some of the financial pressure, they do not make planning any less important. Tax planning will always be crucial since maximum benefits are not automatic. Taxes are only one consideration in the big picture, though. The real point of planning is to pass your legacy to your loved ones with as little complexity, conflict and stress as possible. That can happen only if you properly coordinate a
good succession plan for your family farm alongside your personal estate plan. One without the other is incomplete planning.

Of course, there is a catch. There is a narrow window of opportunity because all of these new transfer tax rules last for only two years. They will automatically expire on Dec. 31, 2012. After that, nobody knows what might happen. The rules might stay the same or get better, but they might be worse. It is wise to act now while you have the chance.

Careful transfer tax planning can reap far greater overall savings than any other type of tax planning. It can mean the difference between the success and failure of the legacy you have spent a lifetime creating. Estate taxes do not destroy family farms—lack of good planning does.
The new transfer tax rules provide the best opportunity for farm succession and estate planning that we have seen in decades. There are several tools available to deal with transfer taxes, but you have to use them wisely to get the full benefit.

Tom O’Diam is an estate and business succession planning attorney in Dayton, Ohio, and a certified specialist in estate planning, trust and probate law. Contact him at tmo@oslawgroup.com or (937) 458-0574.

Financial Benefits of the New Tax Law

Ever-changing tax rules have made it hard for farmers to plan for the future of their farm. Thanks to Congress’ surprising move in December 2010, farmers can now secure the legacy they’ve spent a lifetime creating. The new rule allows for:

a transfer of up to $5 million each or $10 million as a couple during life or after death without tax.

a tax rate of 35% for any transfers more than the exclusion amounts.

an estate tax bill of zero if a farmer’s net worth is $10 million or less.

the ability to use the generation-skipping transfer tax exclusions to transfer your entire estate to future generations for decades with no more transfer tax.